Scandinavian Working Papers in Economics

Umeå Economic Studies,
Umeå University, Department of Economics

No 538: Optimal Taxation and Risk-Sharing Arrangements in an Economic Federation

Thomas Aronsson () and Magnus Wikström ()
Additional contact information
Thomas Aronsson: Department of Economics, Umeå University, Postal: S 901 87 Umeå, Sweden
Magnus Wikström: Department of Economics, Umeå University, Postal: S 901 87 Umeå, Sweden

Abstract: This paper analyzes optimal taxation and risk-sharing arrangements in an economy with two levels of government. Both levels provide public goods and finance their expenditures via labor income taxation, where the tax base is responsive to the private agents' labor supply decisions. The localities are assumed to experience different random productivity shocks, meaning hat the private labor supply decisions as well as the choices of income tax rates are carried out under uncertainty. Part of the central overnment's decision problem is then to provide ax revenue sharing between the local governments. The optimal degree of revenue sharing depends on whether or not the localities/regions differ with respect to labor supply incentives.

Keywords: Optimal taxation; multilevel government; fiscal externalities; uncertainty; risk-sharing

JEL-codes: D61; D62; D80; H21; H71

24 pages, September 6, 2001

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